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ANALYSIS: Capacity crunch ahead in Europe

By Dave Leggett | 18 September 2012

Fiats Pomigliano dArco plant was temporarily closed for much of the summer and looks vulnerable

Fiat's Pomigliano d'Arco plant was temporarily closed for much of the summer and looks vulnerable

As the car market declines further in Europe, it is becoming clear that production overcapacity is a more pressing issue for some than for others. The problem is easily described, if not easily solved.

Put simply, as car demand in Western Europe has plummeted it has left a yawning gap between what the market can absorb and what manufacturers can produce. Plant capacity utilisation rates have declined beyond the level at which profitability can be maintained as orders have dried up. Discounting in volume segments is widespread. Abnormally high 'pre-registrations' by dealers in the UK have been a sign that some manufacturers with plants on the continent want to take advantage of the sterling-euro exchange rate to shift more metal in Britain.

Tensions between manufacturers have also risen. The German carmakers are resisting a proposal by Fiat's Sergio Marchionne, who currently serves as president of the European auto industry trade association ACEA, to seek support from the EU to reduce surplus capacity in the region. The Germans are less dependent than Fiat and the French on the European car market. Marchionne has also publicly criticised Volkswagen for heavy discounting activity that is creating a 'bloodbath' in Europe. As Europe's economic crisis bites, tensions could rise further.

Little relief in prospect on the demand side

On the demand side, there is little prospect of relief from a rising tide of recovery to raise plant capacity utilisation rates. Europe's economy is stalling under the weight of the eurozone sovereign debt crisis and austerity budgets. A sharp recovery is not in prospect in 2013, with the forecasters cautiously predicting a shallow upturn. The scale of the downturn since 2007 is sobering. LMC Automotive forecasts that the West European car market will decline by almost 8% to 11.8m units in 2012. That compares with a market of 14.8m units in 2007. Italian car sales continue to slip back and it looks as though a full year market fall of at least 20% is in order, LMC says. The French market is also struggling and is forecast to fall below 2m units for the full year, the first time this will have happened since 1998. Spain's car market is running at less than half of what it was in the good times. And even the German car market now appears to have run out of steam, German consumers not immune to the confidence sapping across the region that has been a consequence of the ongoing and drawn out eurozone economic crisis.

European car production takes a hit

European car production has been hit this year as domestic demand has fallen further and exports to the rest of the world have faltered (for the second quarter, LMC estimates that car exports turned negative for the first quarter since 2009). For the year, LMC forecasts that European light vehicle production will be down 6% at 19.3m (with 2013 forecast flat). That leaves industry capacity utilisation at 65% for 2012 and excess capacity up 1.6m for the year to a whopping 10m.

The overall scale of the overcapacity problem certainly looks daunting, but the picture varies considerably from OEM to OEM. Market geography and model cycles are among the factors that will determine plant capacity utilisation and average capacity utilisation for the OEM. According to LMC's analysis, BMW, Volkswagen and Mercedes-Benz are well above the 65% industry capacity utilisation average (BMW at nearer 85%) for 2012. Fiat is in bottom place at under 50% with Ford Opel, PSA and Renault a little above or below the 65% average.

The challenge facing the manufacturers, according to LMC analyst Arthur Maher, is to get to a capacity utilisation rate of around 80%, which he sees as the level where the manufacturer needs to be to be profitable.

“There are some difficult decisions to be made,” he acknowledges. “It's hard to see how further plant closures can be avoided for some if they really want to get into capacity utilisation territory that enables them to be profitable.”

For Fiat, taking two plants out may be unavoidable

Fiat is struggling this year as the Italian car market has collapsed and CEO Sergio Marchionne appears to be well aware of the overcapacity issues, though he has also muddied the waters somewhat by putting pressure on Italian labour unions for productivity concessions tied to decisions on capacity changes. He has threatened a plant closure in addition to already shuttered Termini Imerese. If that were to happen, the Fiat Pomilgliano d'Arco plant which makes the Panda appears to be a candidate. It has already been subject to significant downtimes this year as production has had to be curbed amid involuntary stock-build. Could the Panda assembly line be moved to another plant? It wouldn't be easy and it would come with high costs, but it is possible. Another strategy would be to follow the model cycle and wait, putting the next Panda (due 2018) into another plant.

Based on current capacity and no further plant closures, LMC estimates that Fiat capacity utilisation in 2017 would be around 70% - still way under the level needed to be in profit. There have been suggestions lately that Fiat might be able to muddle through with short-time working and not have to resort to a further plant closure. Maher doubts that could work.

“I think there may be an element of wishful thinking there. Short-time working alone would mean carrying excess capacity on an indefinite basis which means incurring overheads that are a drag on profitability,” he says. “These are tough decisions, of course, but getting to profitability is very difficult if you have too many plants with the ability to make more cars than you can actually sell.”

LMC's analysis suggests that closing Pomigliano would leave Fiat in 2017 with a rate of capacity utilisation of 78%, much closer to the notional profitability threshold of 80%.

“Fiat's looking a lot healthier in that scenario,” Maher adds.

Opel and PSA also face tough decisions

What about the other volume OEMs who are being squeezed in Europe?

LMC's projections point to Opel, PSA and Renault looking relatively weak in 2017 based on their current capacity set-ups, with capacity utilisation rates forecast at 70% or less.

The losses GM is racking up in Europe (likely to be around $1bn for 2012) are already a worry to the company's bosses in Detroit. LMC estimates current capacity utilisation for GM in Europe of not much more than 60%. LMC's analysis suggests that it needs to shut the Bochum plant in Germany as well as Antwerp just to get to an estimated 77% capacity utilisation in Europe by 2017.

“The question for GM might well be, given its losses in Europe and the timescales involved, is shutting Bochum going to be enough?” says Maher.

Similarly, PSA's plans to shutter its Aulnay plant will leave it at a projected 75% utilisation rate in 2017. If it also shuttered the vulnerable Villaverde (Madrid) plant in Spain, that would give it a capacity utilisation level of 82% on LMC's figures.

LMC's figures need to come with a standard health warning that all forecasts carry. For example, the global economy may turn out to be stronger than many are predicting and the same could be said of the European economy and car market. After several years of below trend markets, replacement demand might kick-in in 2014 or 2015. Indeed, renewed scrappage incentives from governments can't be entirely ruled out either. Higher demand would lift capacity utilisation rates all round. And at the OEM level, product actions can change things markedly (if you have a hit model, the depressed state of the overall market is less of a problem). While the next year can be projected with a high degree of confidence, the risks to the forecasts, up and down, get larger as we go further out.

However, the LMC projections do suggest that reducing overcapacity will require the serious consideration of further tough actions beyond those already planned, especially from those manufacturers currently in a relatively weak position. The pressures to reduce structural overcapacity in order to have a shot at profitability in the (likely to remain) challenging European car market environment will be felt for a while yet.